Unvested Stock Explained: Understanding Vested and Unvested Shares

Stock compensation can change your life—or cost you big if you don’t understand how it works. Unvested shares come with risks, restrictions, and opportunities that you should familiarize yourself with if they become part of your compensation plan.

This guide will prepare you to maximize your equity compensation and avoid costly mistakes when dealing with your vested and unvested stock. Whether you’re negotiating a job offer, planning your exit strategy, or figuring out tax implications, you’ll walk away with a clear plan for your shares.

Let’s dive in.

What Is Unvested Stock?

Unvested stock refers to shares that have been granted to an employee but aren’t fully owned yet. These shares are subject to a vesting schedule, meaning the recipient must meet certain conditions—like staying with the company for a set period—to gain full ownership.

Vested vs. Unvested Shares

• Vested shares: Shares you fully own. You can sell, transfer, or hold them.
• Unvested shares: Shares that are still tied to the company’s requirements. If you leave the company before they vest, you may lose them.

Companies use stock vesting as a retention tool, ensuring employees remain with the company to earn their full stock grant.

How Do Vesting Schedules Work?

A vesting schedule dictates how and when unvested shares become yours. Companies use vesting schedules to incentivize employees to stay and contribute to long-term growth. The most common types of vesting schedules are time-based, milestone-based, and hybrid vesting, each with its own implications:

Time-Based Vesting

The most common type, time-based vesting, releases shares gradually over a set period. A typical structure follows a four-year vesting schedule with a one-year cliff. This means an employee must stay with the company for at least a year before earning any shares. After this initial “cliff” period, the remaining shares vest in monthly, quarterly, or annual increments.

For example, if an employee is granted 10,000 restricted stock units (RSUs) with a four-year vesting schedule and a one-year cliff, they won’t receive any shares during the first year. At the one-year mark, 25% (2,500 shares) will vest at once. The remaining 7,500 shares will then vest monthly or quarterly over the next three years. If the employee leaves before the cliff, they forfeit all unvested shares.

Milestone-Based Vesting

Unlike time-based vesting, milestone-based vesting is tied to specific goals rather than a set timeline. These goals can include company performance metrics, product launches, revenue targets, or individual achievements. This type of vesting is common in executive compensation packages, startup founder agreements, and sales-driven roleswhere stock rewards are tied to measurable success.

For example, a startup founder might receive unvested shares that only vest if the company reaches $10 million in revenue or secures Series B funding.

Milestone-based vesting can be riskier for employees because factors outside their control—like market conditions or leadership decisions—may impact whether they ever receive their shares. However, it can also lead to faster vestingif goals are achieved quickly.

Hybrid Vesting

A hybrid vesting schedule combines elements of time-based and milestone-based vesting. Employees must meet both a time commitment and performance-based milestones before shares vest.

Hybrid vesting is often used in high-growth startups and executive compensation packages, balancing retention incentives with performance-based rewards.

What Happens to Unvested Shares If You Leave the Company?

If an employee leaves the company, unvested shares are typically forfeited. That said, certain factors determine what happens:

• Stock options: If you have vested stock options, you may have a window (usually 90 days) to exercise them.
• Restricted stock: If you haven’t met the vesting conditions, the company may repurchase unvested sharesor reclaim them outright.
• Stock grants: Some companies offer provisions that allow partial vesting or accelerated vesting in specific scenarios.

In the case of an acquisition, an acquiring company may modify the vesting schedule or offer cash buyouts for unvested shares.

Types of Stock Compensation

1. Restricted Stock Units (RSUs)

RSUs are company shares given to employees but subject to a vesting schedule. Once vested, they convert into actual shares. RSUs don’t require an upfront purchase but may have tax implications upon vesting.

2. Stock Options (Incentive & Non-Qualified)

• Incentive Stock Options (ISOs): Favorable tax treatment if held for a specific period.
• Non-Qualified Stock Options (NSOs): Taxed as regular income upon exercise.

Both types require you to exercise stock options at a predetermined strike price before they expire.

3. Restricted Stock Awards (RSAs)

RSAs are granted outright but are subject to forfeiture if vesting conditions aren’t met. Unlike RSUs, RSAs often require employees to purchase shares upfront.

Tax Implications of Unvested Stock

Taxes on stock compensation vary based on the type of equity, when it vests, and whether the employee chooses to exercise stock options. Failing to plan for taxes can lead to unexpected liabilities or missed opportunities for tax savings.

RSUs

RSUs are taxed as ordinary income upon vesting. Employees do not owe taxes when RSUs are initially granted, but once the shares vest, the fair market value (FMV) at the time of vesting is considered taxable income. This means the value of vested RSUs is added to an employee’s salary for that tax year, potentially pushing them into a higher tax bracket.

For example, if an employee receives 5,000 RSUs that vest when the stock is valued at $50 per share, they will owe income tax on $250,000 of additional compensation, even if they don’t sell the shares immediately. If the employee holds the shares after vesting and later sells them at a higher price, any gains are subject to capital gains tax. If sold within one year, gains are taxed at short-term capital gains rates (same as ordinary income). If held for more than a year, the lower long-term capital gains rate applies.

Stock Options: NSOs vs. ISOs

Stock options can be taxed in a few different ways:

• NSOs: When an employee exercises NSOs, the difference between the exercise price (strike price) and the FMV at exercise is taxed as ordinary income. If the employee later sells the stock, any additional gains are taxed as capital gains.
• ISOs: ISOs have more favorable tax treatment but come with stricter rules. Employees do not owe taxes when exercising ISOs, but if they sell the shares within a year of exercising or within two years of the grant date, the gain is treated as ordinary income (a “disqualifying disposition”). If they hold for more than a year after exercise, gains are taxed at long-term capital gains rates. However, exercising ISOs can trigger the Alternative Minimum Tax (AMT), which may require additional tax planning.

For example, if an employee is granted 1,000 stock options at a $10 strike price and exercises them when the stock is trading at $50, they will owe taxes on the $40 per share spread ($40,000 total for 1,000 shares) if they are NSOs. If they are ISOs and hold the shares for more than a year after exercise, they may qualify for lower long-term capital gains rates.

Restricted Stock and the 83(b) Election

Employees who receive RSAs can file an 83(b) election, allowing them to pay taxes on the stock’s value at the time of the grant instead of when it vests. This can be advantageous if the stock price increases significantly over time.

For instance, if an employee is granted 10,000 restricted shares at $1 per share, they can choose to pay ordinary income tax on $10,000 at grant rather than waiting until the shares vest. If the stock later appreciates to $50 per share, they avoid being taxed on the $500,000 FMV at vesting. Instead, any gains upon sale are taxed as capital gains.

However, there’s risk involved—if the employee leaves the company before the shares vest or if the stock price drops, they’ve already paid taxes on shares they may never fully own or that lose value. The 83(b) election must be filed with the IRS within 30 days of the stock grant, making it a time-sensitive decision.

Taxation of Dividends on Unvested Shares

Some restricted stock grants allow employees to receive dividends on unvested shares. Whether these dividends are taxable depends on the company’s policies and how the stock is structured:

• If dividends are paid outright, they are typically taxed as ordinary income in the year they are received.
• If dividends are reinvested into additional shares, they may not be taxed immediately, but could be subject to taxation when the shares vest.

If you receive dividends on restricted stock, these may also be taxable depending on the company’s policies.

Repurchasing Unvested Shares

Many stock plans include a buy-back provision, allowing the company to repurchase unvested stock if an employee leaves.

• Stock purchase agreements may outline a repurchase price (often the original grant price).
• Company policies dictate whether repurchased shares return to the equity pool or are retired.
• If a company grows, repurchased shares might be redistributed to new employees.

If an employee leaves the company, unvested shares may be repurchased by the company within a set period.

What Happens to Unvested Stock in an Acquisition?

When a company is acquired, unvested shares don’t always transfer seamlessly to the new ownership. The fate of these shares depends on the terms of the acquisition deal and the policies of the acquiring company. Generally, unvested shares may be accelerated, converted, or forfeited, each with different financial consequences.

Accelerated Vesting

In some cases, an acquisition triggers immediate vesting of unvested shares. This can happen if the company’s stock plan includes a single-trigger or double-trigger acceleration clause. Single-trigger acceleration vests shares automatically upon acquisition, while double-trigger requires both an acquisition and an employee termination or role change. Accelerated vesting allows employees to fully own their shares sooner than expected, maximizing their payout.

Converted Shares

Instead of canceling unvested shares, the acquiring company may convert them into equivalent shares of its own stock. This means employees retain their equity but under a new vesting schedule. The conversion ratio depends on the terms of the acquisition and the valuation of both companies. Employees should review whether the new vesting terms are favorable and if the acquiring company’s stock has strong growth potential.

Forfeited Shares

If the acquiring company does not honor unvested shares, employees may lose them entirely. This often happens when the new company restructures compensation plans or decides not to continue the existing equity program. In some cases, employees receive a cash payout instead, but this is not guaranteed. Understanding the company’s policies before an acquisition helps employees prepare for potential losses or renegotiate their compensation.

Action Steps: Maximizing Your Stock Compensation

1. Understand your vesting schedule: Know when your shares vest and what conditions apply.
2. Plan for taxes: Work with a tax professional to navigate tax implications effectively.
3. Stay informed: If your company’s stock rises in value, timing your exercise and sale can make a big difference.
4. Negotiate wisely: If joining a startup, negotiate equity compensation terms to maximize your upside.
5. Know your rights: Read your stock purchase agreement and be aware of any buy-back provisions.

Want expert guidance on optimizing your equity compensation? Summitry can help you navigate stock plans, tax strategies, and financial planning to get the most from your shares.